Ethereum vs. Stellar - Which blockchain platform is best for Security Tokens?

Ethereum vs. Stellar - Which blockchain platform is best for Security Tokens?

March 07, 2023

The world of digital finance has witnessed an explosion in recent years, and security tokens have become one of the hottest topics recently as the space moves toward real-world use cases in the face of centralized exchange blow-ups. 

“Security tokens” are tokens that represent real assets, including ownership of real assets, revenue sharing (like stock dividends), futures, options, mutual funds, or a combination of these attributes. Security tokens offer a new way of raising funds, and providing secondary markets, since they allow access to a global market of investors, as opposed to traditional stock markets which generally operate within a single country. 

When it comes to launching a blockchain based security token, two of the most popular platforms are Ethereum and Stellar. Both platforms have their own unique advantages and disadvantages.

Why are so many companies issuing security tokens?

The first question many people ask is why issue on a blockchain? Countries such as France, Germany and others have implemented DLT laws in which blockchains represent legal records for issuing equity, like shares in publicly traded companies. But is there really an advantage in using them?

Currently, issuing tokens at many banks or brokerage firms is relatively “old school” when it comes to securities. Their “stack” might look something like this:

  • Excel spreadsheets for recording allocations.
  • Manual emails to get an ISIN (International Securities Identification Number).
  • Phone calls to verify shareholder participation. 
  • Manually creating new tokens in the back book of record.
  • Manual allocation of the security to various accounts.
  • Manual review of legal documents.

In the case of shares, after-issuance custodianship is often managed by a local legal custodian. If a bank is the issuer, the bank itself may handle management.

If the securities are issued on a stock exchange there can be quite a few listing, legal, and audit fees. Typically, the issuing broker takes a fee of approximately 5%. The overall costs for a new listing can cost up to 20% of the capital raised.

After this there are audit costs, listing fees, marketing making costs and ongoing legal fees. Issuing a security on a blockchain means eliminating many or most of these costs, dramatically lowering costs and often improving operational efficiency and reducing human error.  In the US remaining listed on a major exchange typically can cost up to 1 million per year. And custodians such as BNY Mellon can charge up to $10 USD for every transaction if the shares are listed overseas.

So in short DLT or Blockchains can automate a lot of semi manual processes, remove middlemen and allow for self custody.

Advantages of Ethereum

Ethereum’s main advantages are that it has a large developer community and a large pool of on-chain liquidity. 

More developer support means there is a huge range of software tools and libraries, which gives you a lot of flexibility in terms of what you can do as well as making development easier. For example, Ethereum smart contracts use the Ethereum Virtual Machine (EVM) for creating smart contracts. This makes it possible to automate many functions of a security, such as distribution, dividend payouts, and voting. 

Additionally, Ethereum has a relatively mature infrastructure, including decentralized exchanges and wallets that support security tokens such as those following the ERC-20 format or ERC-223. If you are concerned about security you can leverage the OpenZepplin contact format to ease issuance.  This means there are lots of venues for trading and storing the token, and more options for selling tokens and moving the proceeds into traditional bank accounts. 

Disadvantages of Ethereum

Ethereum has been plagued by slow transaction speeds, criminal activity, and high fees. The Ethereum network is prone to congestion during periods of high demand, which can slow down transactions and increase fees. This can be a problem for security token issuers who need to transfer large amounts of tokens quickly, compliantly, and cost-effectively. 

Advantages of Stellar

Stellar, on the other hand, is known for its fast transaction speeds, low fees, and built-in infrastructure for regulatory compliance. 

The Stellar network can process thousands of transactions per second, making it ideal for security token issuers who need to transfer large amounts of tokens quickly. While the Stellar ecosystem is not as big as Ethereum, there are still plenty of high quality wallets, exchanges platforms to use as tools when working with the network. 

Stellar also has a user-friendly developer interface since it is targeted more toward the financial sector, whereas Ethereum is more oriented toward software developers and can have a steeper learning curve. 

Stellar also does not have some of the reputational issues as Ethereum, which has seen a number of high-profile hackson smart contracts. 

Stellar has some features that make it perfect for issuing security tokens— in particular, clawback can be used to issue options or futures contracts with predetermined expiration dates. It also includes a built-in, standardized KYC process. Another feature that helps token issuers to comply with securities laws is SEP-8 (Stellar Ecosystem Proposal 8). This standard allows a company to block trades that might be illegal, such as spoofing, smurfing, or crashing the price of a security beyond some set limit.

Disadvantages of Stellar

Stellar definitely has much less flexibility than Ethereum when it comes to more exotic and experimental decentralized finance applications. This relative lack of flexibility is a natural result of Stellar’s higher security and ease of use. 

That said, Stellar plans to launch its 2nd generation Rust based smart contract platform named Soroban in the near future. This includes an automated wrapping mechanism for classic stellar assets and most of the capabilities of EVM based chains.

Ethereum vs. Stellar - Which blockchain platform is best for Security Tokens?

Comparison Table

FunctionStellarEthereum ERC20
Send (payments)YY
Burn (destroy)Y - Send to issuerY
Limit issuanceY -“Immutable”Y
Authorize holdersYN (possible but not ERC20 spec)
Approve Trades/TransactionsY - SEP 8N
Standardized KYC APIY - SEP 12/24N
Transaction Fees$0.0001$2

Overall, we find that Stellar has a number of features which make it better for issuing security tokens, especially when it comes to regulated financial institutions. BP Ventures has chosen to use the Stellar ecosystem since 2016, and we advise our clients to do the same.

The speed, low costs, and high throughput of the network give it a high degree of scalability. At the same time, its native support for regulatory compliance such as AML/CFT checks and the ability to whitelist trusted parties provides higher security while reducing legal overhead. 

BPV has been active in supporting the development of the network to build in features appropriate for financial institutions (SEP-8 and SEP-24 in particular). Some large financial institutions have already used the Stellar network for issuing assets, including Fidelity (mutual funds) and ABN AMRO (bonds).

How to Issue a Security Token

If you're interested in launching a security token, the process is straightforward on the Stellar network. You will need to:

  • Decide what rights the security token will provide.
  • Choose the jurisdiction to operate in. 
  • Choose a security token issuance platform. 
  • Create an issuing account and distribution account. 
  • Creating the token (which can be simply a trust line and payment).
  • Publish information about your token (in particular a stellar.toml file)
  • Determine the supply and distribution of your token. 
  • What is the asset behind the security? How can it be validated?
  • How will you handle market making / deposit and withdrawal of funds?
  • Consider all information security considerations

The best platform to launch a security token depends on the specific needs and requirements of the issuer. However, unless you absolutely need an existing smart contract that Ethereum can support, in our opinion, Stellar is the better choice for prospective security token issuers. 

If you are considering issuing a security token, BPV is able to assist with all aspects of planning and issuance. Contact us today for a free consultation. 

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